Firms Rethink Partners' Pay as Leverage Declines

by Joel A. Rose

Dramatic economic changes in most larger law firms have had profound effects on the attitude of management about “leveraging associates.”

Leveraging associates means that when a firm, for example, has three associates for every one partner, those associates will produce more revenue than the one partner. The associates, however, will earn significantly less than the partner while generating the huge profits necessary to pay the partner’s salary, regardless of the partner’s own billable hours. Such a process allows the firm leverage in how to use associates and partners to produce revenue.

It is well-known that during the past several years, many mid-size and larger law firms have increased their partnership ranks and decreased their number of associates. Some firms that once had a 2- to-1 associate-to-partner ratio now have more partners than associates. A few large firms now have twice as many, or even three times as many, partners as associates.

A few years ago, law firms grew rapidly, and there was plenty of cash to go around. Firms relied on associates to record substantial numbers of hours and to generate large fees. Now the benefits once derived from leveraging associates has dried up. This is due to the declining volume of associate-intensive work, such as exhaustive research that a partner wouldn’t normally do. As a result, the value of leveraging associates has decreased, as associates who once might have been considered “profit centers” by their firms have become “cost centers.”

Pay Your Own Way

Partner compensation has been profoundly affected by the reduction in the number of associates. Most larger law firms can no longer afford to have partners who are unable to pay their own way. Many of these firms are expecting their partners to work harder and are evaluating partner performance accordingly.

To help make this assessment, these firms are establishing written standards against which partner performance may be compared. Such standards enable each partner to know what counts in the compensation process. The standards also allow partners to assess relative contributions to the firm, each partner’s own contribution, and the contributions of others.

Fewer firms have attempted to apply a strictly objective compensation formula to analyze each partner’s contribution. Such formulas tend to be rigid because they rely solely on quantifiable items such as billable hours, receipt of accounts receivable and the like. It is true that partners’ contributions to the financial bottom line are easier to assess than their non-quantifiable, subjective contributions. But it is widely believed that such formulas are not appropriate for every firm because they overlook the need for diversity in the assessment factors. Also, applying a strictly objective formula compensation system, partners may be inclined to hoard work (so they may increase their number of billable hours and revenue from personal production) rather than delegating work to others who are competent to perform this work and receive the benefits of leveraging work.

A strictly objective compensation formula might penalize a partner who had toiled for months over a case in which the client hadn’t paid the bill yet. A more subjective compensation formula would take into consideration the partner’s hard work as well as the reliability of the client.

Most larger firms use a subjective evaluation process for their partners. For the system to be administered well, a number of things must happen:

Management must be flexible enough to recognize and accommodate conflicting objectives between the firm and individual partners.

The managing partners must be logical, objective and fair.

The compensation committee must be capable of weighing a wide range of subjective factors.

The firm’s administration must be able to recognize the changing needs and contributions of the partners as the firm evolves.

The managers must be reasonably consistent when evaluating the partners’ contributions.

Compensation Compression

Top-heavy law firms that have not addressed their approaches for evaluating partner performance have experienced compensation compression at the partner level.

Compensation compression means that as time goes on, current partners’ compensation remains at roughly the same level, while incoming partners’ compensation starts at a level not far below. As a result, the difference between compensation levels if compressed.

Unless partners view themselves and their contributions to the firm honestly and realistically, the stability of many established law firms may be at risk. In more and more firms, compensation committees are being tested as they seek to address perceived inequities among partners.

For example, junior partners may feel that they work harder and earn less than senior partners. Some compensation committees have responded by asking several older partners to “give back” some of their earnings, which are pooled to raise the salary of a hard-working younger partner.

Partners may assume diverse roles and responsibilities as part of a restructured compensation plan. Some partners may take on the rainmaker’s role almost exclusively; others may devote themselves to the firm’s management, or to development of non-legal business ventures.

Partners capable of originating and retaining business can be rewarded for doing so in the firm’s compensation scheme. Those who are unable to not inclined to generate business can be expected to spend more hours on writing and research, on training associates or on managing the firm. The compensation structure should enable them to receive variable draws or salaries commensurate with these responsibilities and their performance.

Increasingly, partner compensation serves as a scorecard that reflects each partner’s total contribution as measured against the performance of other partners, with minimal regard for tenure. Partners’ net earnings may go up or down, remain at the same compensation levels or skip levels upward or downward, based upon their performance. The growing belief is that partners’ compensation should not increase automatically merely because the firm had a good year.

Partners in larger law firms can contribute to their value by doing more work themselves and less overseeing of associates. In many large firms, management is placing more of the burden on department heads and individual partners to identify and implement compensation plans.

Partner Pay Ratios

Traditionally, the compensation ratio between the highest and lowest paid law firm partners has been between 2-to-1 and 3-to-1. To attract and retain “overachievers,” some firms have compensation ratios as high as 5-to-1, or higher.

But what constitutes an appropriate ratio, and where particular partners are slotted on the compensation scale, is best determined by a compensation process that properly assesses the contributions of each partner.

More firms are budgeting bonuses to reward lawyers when their performance is extraordinary. Eligibility for bonus payments should depend on objective and subjective contributions that exceed simply “being a good lawyer.” Taking a large part in management, handling a complex trial, participating extensively in American Bar Association activities or producing substantial outside written work might be some ways to satisfy these criteria.

The test of any compensation system is how effectively each partner’s contribution is recognized. Refusing to acknowledge the necessity of articulating clear compensation criteria and allocating profits accordingly is to refuse to recognize the current economic realities of practice law. Such a refusal may eventually dissolve the glue that keeps a law firm together.